What is Upper Circuit and Lower Circuit in Share Market?

An upper circuit refers to the maximum increase in a stock's price in a single trading session, temporarily suspending trading to prevent inflated prices and market bubbles. However a lower circuit refers to the maximum decrease in a stock's price, preventing market crashes. The upper and lower circuits play an important role in regulating stock market instability.  These circuits show the maximum percentage of increase or decrease that is allowed in the price of a specific stock or index during a single trading session. These price bands are settled daily allowing the market authorities to check the fluctuations. To navigate the complexities of stock market dynamics, understanding these circuits is important. In this blog, let’s understand in depth what is upper and lower circuit in share market. 

Upper Circuit and Lower Circuit Meaning

Understanding what is upper circuit in share market and lower circuits in the share market involves grasping the concept of circuit breakers—control mechanisms that stock exchanges use to prevent excessive price fluctuations and protect the market. Usually, circuit breakers are triggered when the price of a stock reaches a predetermined limit, after which trading is temporarily suspended to prevent large price changes.

In the share market, an upper circuit is the highest price limit set by the stock exchange for a stock on a given trading day. If the stock's price hits this limit during trading hours, trading is paused, and no further transactions can occur for that day. The stock's price will then be determined when the market opens in the next trading session based on new buy and sell orders. Conversely, a lower circuit in the share market is the lowest price limit. If the stock's price reaches this limit, trading is also halted, preventing any more trades for the rest of the day.

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What drives the Upper/Lower Circuit?

There are several factors that drive the upper and lower circuits in the stock market as mentioned below

• Market Sentiment: Positive or negative news from a company or the market influences the stock price to hit the upper or lower circuit. 
• Indicators of the Economy: Fluctuation in the economic indicators—GDP growth, inflation rate, interest rates—drives the price of the stock. 
• Corporate Announcements: These normally include the declaration of dividends, bonuses, stock splits, mergers, etc., which may make stock prices shoot up, or crash down.
• Regulatory Announcements: Decisions or policy changes by regulatory bodies result in stocks hitting their upper or lower circuits. 
• Global Events: It involves global happenings such as geopolitical tension, a pandemic, or any other major change in economies that may influence changes in stock prices.

Difference Between Upper Circuit and Lower Circuit

Let's explore the fascinating difference between upper and lower circuits and how they affect market participants.

In both scenarios, the upper and lower circuits create a sense of anticipation and change the trading dynamics. Traders closely monitor stocks nearing these circuit limits, as breaching them signifies a shift in market sentiment and a potential opportunity for profits or losses.  

Five Essential Facts of Upper and Lower Circuit

Here are five important facts regarding the upper and lower circuits.

1. Circuit filters are based on the previous day's closing price: The upper and lower circuit levels are calculated using the stock's last day's closing price. These circuit filters help regulate the price movement of stocks.
2. Circuit filter information is available on the stock exchange's website: The specific upper and lower circuit limits for each stock can be found on the website of the respective stock exchange. Traders and investors can access this information to stay informed about circuit levels.
3. Stocks typically have a 20% circuit limit: Initially, stocks are assigned a 20% circuit limit, which means that the stock price can fluctuate within a range of 20% from the previous day's closing price. This percentage may vary for different stocks.
4. Upper circuit indicates maximum price increase; lower circuit indicates maximum price decrease: When a stock hits its upper circuit, it implies that its price has reached the maximum limit allowed for the day, resulting in a temporary halt in trading. Conversely, hitting the lower circuit means the stock's price has dropped to the maximum limit allowed for the day.
5. Intraday trades are converted to delivery when circuit limits are hit: When a stock hits either the lower circuit and upper circuit in share market, intraday trades in that stock are automatically converted to delivery trades. This conversion is necessary as trading in the particular stock is halted for the rest of the trading day, allowing only delivery-based transactions.

Upper and Lower Circuits for Stocks

Every day, stock exchanges establish a price band based on the stock's last traded price. The goal is to safeguard investors against significant single-day price changes (increase and decline). Upper and lower circuits (as stated in the preceding paragraph) in stock markets are done solely to safeguard them from the stock market's extreme volatility.

Upper and Lower Circuits for Indices

Circuits aren't always used for individual stocks; they may also be used for an index. As a result, when an index drops drastically, the circuit breaker system raises a red light. India has derivative markets. This is the halt index. When this happens, trade in equities and futures markets is paused, which can take a few minutes to the rest of the trading day. It is determined by the proportion of the index's decline.

How to Use Circuits or Price Bands on Stocks to Your Advantage?

The NSE and BSE determine the price bands for all securities. Most investors, particularly individual investors, prefer to invest in mid and small-size equities. In either case, such stocks are subject to dramatic volatility. Circuit filters assist these tiny investors by protecting them from large losses. If you've already invested in a company, it's best to sell when you detect the circuit level rising. Mild volatility is often associated with limited earning potential.

Conclusion
Understanding upper and lower circuits is crucial for navigating the stock market effectively. These price limits are essential mechanisms that help regulate trading activity and maintain market stability, preventing extreme volatility. Whether you're an experienced trader or a new investor, understanding the significance of these circuits allows you to make informed decisions and mitigate risks. Utilising tools like an online trading app can further enhance your ability to monitor these price bands and optimise your trading strategy. Stay informed, and leverage these insights to your advantage in the dynamic world of stock trading.